Monday, February 24, 2014

Global monetary
policy took a turn toward continued low interest rates last week as Chile and
Hungary extended their easing cycles while the Bank of Japan (BOJ) sent a clear
signal that it will not let up on quantitative easing until it’s completely convinced that
it has escaped the ogre of deflation.

Reinforcing the message that monetary
policy will remain loose for some time, finance ministers and central bank
governors from the Group of 20 (G20) leading economic nations recognized this weekend in Sydney that “monetary policy needs to remain accommodative in
many advanced economies” with the normalization of policy conditional on the
outlook for price stability and economic growth.

But while there is broad
agreement that monetary policy has to remain accommodative to aid the sluggish
global economy, the U.S. Federal Reserve’s start last month of tapering asset
purchases was clearly on policymakers’ minds when they said monetary policy
should be carefully calibrated and clearly communicated, with central banks
“being mindful of impacts on the global economy.”

It was a clear nod to Raghuram
Rajan, governor of the Reserve Bank of India (RBI), who last month accused the
Fed and other advanced economies of running selfish economic policies and
criticized the lack of international economic policy coordination.

The reference by the G20 that central banks have to be “mindful” of how their national policies affect other
countries shows a growing political consensus toward developing deeper
collaboration among the world’s major central banks amidst volatile asset prices and massive outflows of capital from emerging markets toward advanced economies.

How such collaboration can extend beyond the current informal framework is not clear and the G20 communique didn't go beyond underscoring the need for communication by central banks.

Apart from having each other on speed dial, governors of the world's major central banks only see each other regularly every two months at the Bank for International Settlements (BIS) in Basel, and at more formal intergovernmental occasions, such as G20 meetings.

Meanwhile, minutes from the
BOJ’s policy meeting on Jan. 21 and 22 once again showed the central bank’s
determination to boost inflation and rid the country of some 15 years of debilitating inflation.

In April, when the BOJ embarked
on its latest aggressive easing campaign, its stated aim was to increase inflation to
2 percent “at the earliest possible time, with a time horizon of about two
years” by doubling the country’s monetary base by the end of 2014.

Although Japan’s inflation has
been positive since June, and consumer prices rose by an annual 1.6 percent in
December, the BOJ clearly wants to make sure that financial markets understand
it will not rest until it achieves its goal.

The minutes show that “many
members” of the BOJ policy board believe it is necessary to avoid any
misunderstanding by financial markets and clearly explain that the bank’s
quantitative and qualitative monetary easing will not automatically end in two
years.

In addition, it should also be
clear that any future change to the BOJ’s guidance should not weaken its
commitment to achieving the 2 percent inflation target.

The BOJ minutes showed that
board members still see inflation, excluding the impact of the consumption tax
rise in April, of around 1.25 percent for some time, but there is also the
welcome recognition that inflation expectations are rising.

Economists’ expectations for inflation 2-6
years ahead have been rising since mid-2011 but the latest surveys still only
show expectations of 1.25 percent, according to the minutes.

Japanese
households, however, are more optimistic that inflation will start to rise.

The latest
consumer confidence survey from January shows that 45 percent of households
expect inflation of above 2 percent but below 5 percent a year from now while
only 14 percent expect inflation of less than 2 percent. It is interesting to
note that a full 30 percent of households expect inflation of over 5 percent.

Households’
expectations have clearly been affected by the actions of the Japanese
government and the BOJ, with inflation expectations jumping by a full 8
percentage points in April 2013, the same month the BOJ announced its
aggressive easing campaign.

Surveys from January 2013 showed that only 27 percent of households expected
inflation of 2-5 percent while 22 percent expected inflation of less than 2
percent. Only 11 percent expected inflation to exceed 5 percent.